The sale of real estate generally consists of four distinct phases: first, the matching of a willing buyer with a willing seller; second, contract negotiation and execution; third, a due diligence period in which the contract contingencies are removed, and fourth, the settlement at which time the property changes ownership. The third and fourth phases are together referred to as the closing process.
The first phase of the process is rapidly automating. For example, since the 1980s, real estate agents in most communities have been able to perform computer-assisted searches of residential properties listed for sale with other realtors in the community through their local multiple listing service. Today, numerous Web sites provide consumers with the ability to use the Internet to advertise and search for advertisements of properties for sale throughout the U.S. Pat. No. 5,664,115 covers a process that facilitates the matching of potential buyers and sellers of real estate by permitting automatic screening of potential buyers. U.S. Pat. No. 5,500,793 covers a computerized system to identify properties for possible exchanges.
Although the second phase of the process (contract generation and execution) has not yet been automated in practice, several patents have been issued in this area related to purchase contracts in general. (See, e.g., U.S. Pat. Nos. 5,191,613, 5,692,206, 5,794,207, and 5,970,470). On priceline.com, a consumer can make, and a vendor can accept, via the Internet the consumer's purchase offer for various goods and services. However, currently there is no known process or system that automates the third and fourth phases of the sale of real estate.
The Closing Process: Due Diligence and Settlement
In a typical real estate purchase agreement, the buyer's obligation to purchase, and the seller's obligation to sell, the property are contingent upon the satisfaction of several conditions. To the extent these conditions are eliminated before settlement, they are generally referred to as “contingencies”. To the extent they are satisfied at or after settlement (such as in the case of transfer of title and issuance of a title insurance policy), they are generally referred to as “closing conditions.”
Typically, there are two methods for removal of contingencies (thereby allowing the sale to go forward): the active method, in which the contingency is removed, for example, by notice from the buyer, and the passive method, in which it is removed by expiration of a deadline without notice. The following example is illustrative: Most sales of residential property are subject to a financing contingency. A financing contingency allows the buyer to cancel the sale if the buyer is unable to find a lender who will finance the buyer's acquisition of the property. If the financing contingency is to be removed by the passive method, then the buyer is deemed to have waived or removed the contingency (thereby allowing the sale to go forward) if the deadline expires without notice from the buyer. Conversely, if the financing contingency is to be removed by the active method, then the contingency is not removed (and the sale will not go forward) unless the buyer gives notice of its removal before the applicable deadline.
In a contract for the purchase of real estate, the contingencies generally include buyer's review and acceptance of a title insurance company's commitment to issue a policy of title insurance insuring the buyer's title to the property. Frequently, a financing contingency is also included. Finally, other contingencies such as various inspections of the property may also be included. The purchase contract generally assigns a deadline or expiration date for the satisfaction of each contingency and these deadlines will often differ.
When all of the contract contingencies are eliminated, the due diligence phase is complete and settlement may take place. At or before settlement, the seller executes and delivers to the closing agent certain documents including a deed conveying the property to the buyer; the buyer delivers or makes available to the closing agent the funds sufficient to pay the sale price and the buyer's share of closing costs. The cash to be paid to the seller is equal to the sale price less any loans assumed by the buyer and less any other agreed upon deductions such as the seller's share of closing costs. Prior to disbursement of the finds, the closing agent will prepare, and the buyer and seller may sign, a settlement statement itemizing the closing expenses and showing how the funds are disbursed. The buyer and other parties may also be required to execute certain documents at a formal closing meeting.
Settlement procedures vary on a state-by-state basis. In general, on the East Coast, at the closing meeting, the closing agent disburses the cash consideration to the seller and other parties involved in the sale, such as an existing lender whose loan is being paid off, real estate brokers, the title insurance company, and the closing agent itself. The deed is recorded in the county records immediately thereafter and any required title insurance may then issue. On the West Coast, the funds are disbursed only after the deed has been recorded.
Throughout the country, the current procedures for handling the due diligence and settlement phases are labor intensive, paper driven and prone to error. Although the purchase contract may be generated by a word processor and therefore in digital form, this digital form is not functional; that is, it is not linked to any computer readable rules or procedures for processing the agreed upon contingencies and closing conditions. As a result, in order to eliminate the contract contingencies, a human closing agent (or the parties themselves) must monitor the appropriate deadlines, review any notices from the appropriate parties and then take a further mental step of determining whether the contractual requirements for contingency elimination were met. Similarly, when title insurance is ordered, the parties (or a human closing agent) must review the contract to obtain the relevant information, such as the legal description of the property, the buyer and seller's legal names, the purchase amount and the closing date. If the contract is in digital form, certain time can be saved by cutting and pasting such information from the contract. But a human agent must do this work. Furthermore, when the various parties prepare the deed, the title policy, and other critical transaction documents, the relevant transaction information must be re-keyed or, at best, “cut and pasted” by a human agent. Moreover, the information necessary to prepare the settlement statement (e.g., sale price, balance on loans being assumed, title insurance premium, etc.) must be physically obtained and entered by the closing agent. Finally, because there are so many documents to prepare, review and execute at the closing meeting, the buyer, seller and one or more human closing agents generally must be physically present.
Digital Signatures
Any system that fully automates the closing process should provide a means for authenticating and keeping secure the electronic communications from the parties involved in the transaction. Public key cryptography, a commonly used method for authenticating and protecting such communications, uses two electronic keys, a public key and a private key, both of which are issued by a trusted third party. The private key is known only to the sending party, whereas the public key is publicly available. The keys are mathematically related such that a message decrypted with the public key could have been encrypted only with the private key. Therefore, if a sender signs a document with his private key, the recipient can use the sender's public key to confirm the authenticity of the document. For a comprehensive description of public key cryptography, see Warwick Ford and Michael S. Baum, “Secure Electronic Commerce: Building the Infrastructure for Digital Signatures and Encryption,” Prentice-Hall, 1997, which is incorporated by reference herein.
In the United States, a contract for the sale of real estate is subject to the statute of frauds, which provides that the contract is invalid unless it is in writing and signed by the party against whom enforcement is sought. Over about the past five years, approximately half of the states have passed legislation that specifically authorizes the use of a digital signature in place of a physical signature, thereby satisfying the writing and signature requirement for real estate contracts imposed by the statute of frauds. In addition, many states now authorize the electronic recordation of deeds.